Chapter 8 - Bank Reconciliation PDF

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Chapter 8 - Bank Reconciliation...

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CHAPTER 8 – BANK RECONCILIATION

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Learning Competencies The learners should be able to...

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1. Describe the nature of a bank reconciliation statement 2. Identify common reconciling items and describe each of them 3. Analyze the effects of the identified reconciling items 4. Prepare a bank reconciliation statement Bank Reconciliation Statement o A report that is prepared for the purpose of bringing the balances of cash (a) per records and (b) per bank statement into agreement o More specifically, bank reconciliations are prepared to: 1. Explain the difference between the cash balance reported on the bank statement and the cash balance in the accounting books 2. Arrive at the adjusted (correct) cash balance to be shown in the financial statements 3. Provide information for reconciling journal entries o Prepared on a monthly basis, immediately upon receipt of monthly bank statements from banks o When a business has more than one bank account, separate bank reconciliations are made for each of those accounts Pro Forma Bank Reconciliation Statement Bank reconciliation statement format

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Balance per books, end. - the cash balance in the accounting records as of the end of the current month ▪ In the pro forma statement above, "Balance per books, end." is the cash balance in the accounting records as of August 31, 2016 Balance per bank statement, end. - the ending cash balance in the bank statement of the current month ▪ In the pro forma statement above, "Balance per bank statement, end." is the cash balance on the bank statement as of August 31, 2016 Credit memos - these are additions (bank credits) made by the bank to the depositor's bank account but not yet recorded by the depositor ▪ Examples include: ▪ Collections made by the bank on behalf of the depositor ▪ Interest income earned by the deposit

Proceeds from loan directly credited or added by the bank to the depositor's account Debit memos - these are deductions (bank debits) made by the bank to the depositor's bank account but not yet recorded by the depositor ▪ Examples include: ▪ Bank service charges representing bank charges for fees, interest, penalties, and surcharges ▪ No sufficient funds checks (NSF) - or Drawn against insufficient funds checks (DAIF) - these are checks deposited and already recorded by the bank but subsequently returned to the depositor because the drawer's fund is insufficient to pay for the check ▪ Automatic debits, such as when the depositor and the bank agree that the bank will make automatic payments of bills on behalf of the depositor ▪ Payment of loans - this represents payment of loan which the depositor agreed to be made out directly from its bank account Book errors - errors committed by the depositor (e.g., erroneous recording in the accounting books) Deposits in transit - deposits already made but not yet received by the bank, or received by the bank but not yet credited to the depositor's bank acocunt ▪ Often occur when deposits are mailed to the bank, placed in an overnight depository, made through check and the check has not yet cleared, or made after the bank's cut-off Outstanding checks - checks drawn and released to payees but are not yet encashed with the bank ▪ Exclude the following: ▪ Certified checks - the bank, when certifying checks, automatically debits (reduces) the depositor's account and assumes direct liability on paying the certified checks to the payee; already deducted from the account, thus, they are no longer outstanding ▪ Stale checks - checks that remain outstanding for a relatively long period of time; reverted back to cash, meaning they are added back to the cash balance per books, and are excluded from outstanding checks Bank errors - errors committed by the bank ▪

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Credit memos, debit memos, and book errors are referred to as book reconciling items Deposits in transit, outstanding checks, and bank errors are referred to as bank reconciling items

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Adjusting (reconciling) entries are made only for book reconciling items (i.e., credit memo, debit memo, and book errors) — no adjusting (reconciling entries) are needed for bank reconciling items in the entity's books The reconciling items are determined simply by comparing the amounts in the ledger and the bank statement ▪ Amounts that are in the ledger but not in the bank statement are bank reconciling items ▪ Amounts that are in the bank statement but not in the ledger are book reconciling items ▪ Simply cross-out items that appear in both the ledger and the bank statement — items not crossed-out are the reconciling items Deposit liability - the account title used by the bank; corresponds to the "Cash in bank" account maintained in the depositor's books — these two accounts are the ones that are reconciled in a bank reconciliation

Remember the following: To correct an overstated credit, you need to make a debit (inverse relationship) To correct an overstated debit, you need to make a credit (inverse relationship) To correct an understated credit, you need to make a credit (direct relationship) To correct an understated debit, you need to make a debit (direct relationship) Remember the following (in Filipino): Kapag sobra ang credit (overstated), magbawas gamit ang debit Kapag sobra ang debit (overstated), magbawas gamit ang credit Kapag kulang ang credit (understated), magdagdag gamit and credit Kapag kulang and debit (understated), magdagdag gamit and debit Book Errors o

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Nature of error: Understatement in book debit (Kulang sa pagdagdag) ▪ Effect on ending balance of cash: Understatement (Kulang) ▪ Correction: Debit (Addition on the pro forma reconciliation) (Magdagdag) Nature of error: Understatement in book credit (Kulang sa pagbawas) ▪ Effect on ending balance of cash: Overstatement (Sobra) ▪ Correction: Credit (Deduction on the pro forma reconciliation) (Magbawas) Nature of error: Overstatement in book debit (Sobra sa pagdagdag) ▪ Effect on ending balance of cash: Overstatement (Sobra) ▪ Correction: Credit (Deduction on the pro forma reconciliation) (Magbawas) Nature of error: Overstatement in book credit (Sobra sa pagbawas) ▪ Effect on ending balance of cash: Understatement (Kulang) ▪ Correction: Debit (Addition on the pro forma reconciliation) (Magdagdag)

Bank errors Nature of error: Understatement in bank credit (Kulang sa pagdagdag) ▪ Effect on ending balance of cash: Understatement (Kulang) ▪ Correction: Credit (Addition on the pro forma reconciliation) (Magdagdag) o Nature of error: Understatement in bank debit (Kulang sa pagbawas) ▪ Effect on ending balance of cash: Overstatement (Sobra) ▪ Correction: Debit (Deduction on the pro forma reconciliation) (Magbawas) o Nature of error: Overstatement in bank credit (Sobra sa pagdagdag) ▪ Effect on ending balance of cash: Overstatement (Sobra) ▪ Correction: Debit (Deduction on the pro forma reconciliation) (Magbawas) o Nature of error: Overstatement in bank debit (Sobra sa pagbawas) ▪ Effect on ending balance of cash: Understatement (Kulang) ▪ Correction: Credit (Addition on the pro forma reconciliation) (Magdagdag) Basic Internal Controls Over Cash o Internal control - any action taken or process set by management that is designed to help the business organization achieve its objectives o In its basic sense, we use some sort of internal control every day (e.g., setting of an alarm, proper grooming, etc.) o Inherent risk is normally higher for cash compared with other assets because cash is exposed more to risk of theft and other types of fraud o Adequate and effective internal controls should be in place to ensure that cash is reasonably safeguarded o The following are just a few of the internal controls businesses use to safeguard their cash: 0. Bank reconciliation - an internal control over cash receipts and cash disbursements ▪ Helps reveal errors ▪ As an internal control, bank reconciliations must be performed regularly (i.e., every month) 1. Imprest system - requires that all cash receipts should be deposited intact and all cash disbursements should be made through checks ▪ Cash collections are deposited intact within a reasonable period of time from date of collection and should not be used for any type of disbursement ▪ Disbursements should be made through checks and not from cash collections ▪ Disbursements for small amounts are made through the petty cash fund ▪ Petty - (in layman's terms) means "minor" or "of little significance" o

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Petty cash fund - money set aside to defray recurring expenses that are of relatively small amounts and cannot practicably paid through check ▪ What constitutes a "small" amount is a matter of company policy

Remember that as a process gets more complicated, there will be more room for fraud ▪

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A good internal control in place would provide you (the owner) a reasonable assurance that your collections are not being embezzled ▪ You can build a good relationship with your employees, giving them your trust and confidence A poor internal control gives rise to unnecessary doubt, and too much doubt creates bad relationship

The success of a business organization is founded upon the good relationship of the people comprising the organization Another requirement of the imprest system is that all disbursements shall be made through check — this provides reasonable assurance that all disbursements are authorized by the owner because he/she will need to sign each check disbursement ▪ However, this may not be practicable for small recurring disbursements — thus, there is a need to establish a petty cash fund with an employee authorized as the petty cash custodian having the authority to authorize disbursements from the petty cash fund and in return, he/she has the sole responsibility over the fund and is liable for any shortages 2. Check Disbursement Voucher (CDV) - a report prepared for each check written ▪ Its purpose is to provide reasonable assurance that each check written is properly authorized — this is because the approver's signature must be affixed on each CDV ▪ The approver is normally the business manager (i.e., sole proprietor, managing partner, or president/chief executive officer) ▪

3. Petty Cash Voucher - (similar to the CDV) used to provide reasonable assurance that all disbursements from the petty cash fund are properly authorized ▪ The party authorizing the disbursement should not be the one who either disburses the fund or records the disbursement in the books of accounts

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Chapter 8 Summary o A bank reconciliation statement is a report that is prepared for the purpose of bringing the balances of cash (a) per records and (b) per bank statement into agreement o Pro forma bank reconciliation:

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Credit memos (CM) - additions (bank credits) made by the bank to the depositor's bank account but not yet recorded by the depositor, e.g., collections made by the bank on behalf of the depositor Debit memos (DM) - deductions (bank debits) made by the bank to the depositor's bank account but not yet recorded by the depositor, e.g., NSF checks, bank service charges Deposits in transit (DIT) - deposits made but not yet credited by the bank to the depositor's bank account Outstanding checks (OC) - checks drawn and released to payees but are not yet encashed with the bank...